In this week’s Grumpy Economist Weekly Rant, John Cochrane asks a simple question: can a democracy lend money to its citizens and still expect repayment? Student loans were once largely private—banks financed education for students expected to earn more and repay their debt. But over time, the federal government became the dominant lender, transforming the scale and incentives of the entire system.
Cochrane explains how cheap federal borrowing expanded credit, sending student loans sharply higher while tuition climbed alongside it. As repayment rules weakened and forgiveness programs expanded, a system once expected to generate returns for taxpayers evolved into one producing hundreds of billions of dollars in federal losses.
Transcript
Hi, I’m John Cochrane, senior fellow here at the Hoover Institution, and welcome to the Grumpy Economist Weekly Rant. Today, I’ll be ranting about student loans. Can a democracy lend money to its citizens and ask them to repay?
I’m motivated, of course, because the Trump administration just announced one more forgiveness program. They’re not going to collect money from people who are in default. Biden, of course, forgave student loans to the tune of hundreds of billions of dollars.
To be fair, the Department of Education just announced a sweeping new repayment plan that was going to solve the myriad of confusing previous repayment plans, and then introduced a bunch of new confusing repayment plans, at least as far as I was concerned.
It’s puzzling. Here we are, a long time after loans were made, and we’re changing the terms of repayment over and over again. What’s going on?
Of course, activist groups instantly complain, “Oh no, somebody’s payments might go up. That’s terrible.”
Once upon a time, student loans were largely private. Banks lent money to people who were going into profitable majors, who were going to make a lot of money after they went to college, and then collected it on the backend. A good deal.
What happened? The federal government saw a good thing and got involved. Always a danger sign.
Essentially, the federal government took over the whole market starting in 2010. Why?
Well, many economists said, as well as policymakers, “First, the federal government gets to borrow really cheap. Why shouldn’t its citizens get to borrow at the same cheap rates? We’ll just pass on our borrowing capacity.”
Second, the federal government has what we call politely a “repayment technology.” They can force you to pay back loans through the IRS in a way that a bank can’t force you to pay back loans because I can’t repossess you as I can repossess a car.
And third, of course, the ever-popular: we’ll cut out the middleman and save money.
What happened?
Student loans expanded wildly. Lots of loans went to, shall we say, unprofitable majors and to people who didn’t finish college and then didn’t make any more money when they were done.
Tuition expanded enormously. Colleges know how to take advantage of a subsidy.
There were for-profit colleges, not all of whom are bad, but some of whom recycled student loans back to the students and turned it into a great scam.
Steadily less people were repaying their loans, and the terms for repayment got steadily weaker.
Are you still in school? Oh, you don’t have to repay.
Are you disabled? Don’t worry, you don’t have to repay.
Oh, do you work for a non-profit or for the government or for the Peace Corps? Don’t worry, you don’t have to repay, or you have to repay less.
Do you earn less income? Oh, don’t worry, you have to repay less.
Notice the incentives of all of those not to go into profitable jobs that help people to pay taxes, among other things, to the government.
And then, of course, widespread forgiveness to the tune of hundreds of billions of dollars.
From we’ll make money on this. From subsidized education that went into profitable careers, from cut out the middleman, we quickly turned this into one more hundreds of billions of dollar federal rat hole.
What happened? Can a democracy actually lend money to its citizens and ever ask for repayment?
Good question.
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John H. Cochrane is the Rose-Marie and Jack Anderson Senior Fellow of the Hoover Institution at Stanford University. An economist specializing in financial economics and macroeconomics, he is the author of The Fiscal Theory of the Price Level. He also authors a popular Substack called The Grumpy Economist.
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